Where have all the deals gone?
Sprawling along the shores of Lake Ziway, three hours to the south of Ethiopia’s capital Addis Ababa, AfriFlora’s vast production facility is one of the largest cut flower factories on the planet.
With 38 greenhouses spread over a total surface area of 640 hectares – the size of around 1,300 football pitches – the company produces 65 varieties of roses that garnish wedding celebrations and restaurant tables around the world. In 2013, New York-based private equity giant KKR, keen on gaining exposure to the rapidly growing African market, settled on AfriFlora as its first investment on the continent, negotiating a stake worth around $200m. For the firm’s executives, the flagship investment represented a major statement of intent.
“This first investment reflects the long-term commitment of our firm to the wider African region, Johannes Huth, head of KKR Europe, Middle East and Africa, said at the time. “We look forward to making further investments across the continent through our private equity, infrastructure and energy investment platforms.”
Four years later, that strategy has been abandoned. According to the Wall Street Journal, KKR has disbanded its deal team in Africa, citing a lack of large opportunities on the continent. Four KKR executives and an adviser involved in the strategy have left the firm, according to the newspaper. AfriFlora remained KKR’s sole African deal.
For several excitable years, Africa was considered the next major frontier in dealmaking, an untapped giant offering vast opportunities in mergers and acquisitions (M&A), joint ventures and private equity transactions. Investment bankers, lawyers and angel investors flocked to the continent, scouting out promising targets, setting up local offices and planning their exposure to Africa’s rising consumer and commodities markets.
Yet in 2017, many are beginning to ask whether Africa’s deal bonanza has ground to a halt. As the continent struggles through the aftermath of a commodities slump amid an ongoing series of political challenges, deal flow has taken a major hit. According to Dealogic, there had been 521 Africa-targeted M&A transactions to December 2017 worth $22.8bn, compared to 623 transactions worth $45.5bn for the whole of 2016. This year’s performance harks back to the sluggish dealmaking of the early 2000s, with the boom years of 2007 ($75.5bn) and 2010 ($52.8bn) a distant memory.
From upheavals in South Africa, Tanzania and Kenya to persistent concerns over company accounting, corruption, and the reduced availability of deal targets, several factors have combined to knock the confidence of market players. “I’m not as pessimistic [but] clearly the data doesn’t lie, clearly the megadeals aren’t happening. The size of deals is smaller and the sort of people doing deals is slightly different,” says Andrew Skipper, head of the Africa practice at law firm and deal advisor Hogan Lovells.
Yet despite the gathering clouds, there is robust debate over whether the M&A downturn portends an extended period of straitened corporate growth on the continent – or merely a pause as dealmakers plot their next moves. “I’m not sure it was a bad year for M&A,” says Miguel Azevedo, head of investment banking for Africa at Citigroup. “I think a lot of business got started this year that will be done in 2018. The pipeline for 2018 is definitely better than it was for 2017 last year… I expect it to be a very decent year.”
After an annus horribilis marked by the sacking of a respected finance minister, deepening allegations of widespread government corruption and a bitter political fight to succeed President Jacob Zuma, ratings agency S&P’s patience with South Africa finally snapped in November. With its decision to downgrade the country’s local currency debt to junk status, S&P offered another red flag to investors mulling their future in the country. The evidence suggests they are heeding the warning.
M&A transactions in South Africa are predicted to drop to just $4.5bn in 2017, less than half of 2016’s $10.7bn haul, according to law firm Baker McKenzie’s Global Transactions Forecast. For Morné van der Merwe, managing partner at Baker McKenzie in Johannesburg, the reasons for the downturn are obvious.
“Political uncertainty, state capture, the narratives around corruption – it makes it very difficult to present yourself as an attractive destination for inbound investment if you have those dynamics around,” he explains. “It’s quite clear that the tentacles of state capture have found their way into normal commercial life – we’ve crossed that line and investment confidence is lower than it used to be. Due to the downgrades and potential for further downgrades, the cost of raising capital for acquisitions has also become more expensive.”
The symbiotic relationship between macroeconomic certainty and M&A activity – whether in South Africa or elsewhere – is no secret. And in 2017, Africa has seen more than its usual share of political upheavals in major markets.
From the botched double election in Kenya to Nigerian President Muhammadu Buhari’s illness and the battle that Tanzanian President John Magufuli has waged with international mining houses, the continent’s leaders have offered pause for thought to would-be dealmakers. According to a November report by the African Private Equity and Venture Capital Association (AVCA), 38% of general partners said that political changes had a detrimental impact on their investments, while 48% said political risk had caused them to amend exit plans.
“Africa has always been a tougher place to transact than more mature markets. And you’re throwing in factors at play in the last 12 to 18 months, with currencies in Nigeria, Angola and others, and political uncertainty in Kenya and issues on the investment side in Tanzania,” says David Harrison, senior associate and M&A expert at Hogan Lovells.
“Because life is a little more complicated I do wonder whether that’s led to some people who are not pure play African investors being receptive to opportunities in other markets,” he adds.
Perhaps one of the most imposing obstacles to M&A this year has been currency volatility, a problem closely intertwined with political risk and exacerbated by policy choices. For dealmakers, the ability to move money freely into and out of the markets in which they have invested is critical – the AVCA found that 63% of general partners viewed currency and commodity price volatility as the most important macro factor in Africa over the last three years.
Spurning this advice, President Buhari implemented a strict foreign exchange regime in a bid to prop up a naira flagging under low oil prices. While the Nigerian government has gradually rowed back on the measures, the damage to investment prospects has been extensive. M&A activity nosedived, with just $716m worth of transactions this year compared to $1.2bn in 2016. Such volatility – which has also affected Angola’s kwanza and South Africa’s rand – makes settling on a transaction value fiendishly difficult during lengthy deal negotiations.
“You have a buyer and seller who have a meeting of minds on price based on the current exchange rate. It then takes a number of months to do due diligence and over that period exchange rate volatility can leave them with a very different economic deal,” says Harrison.
Even in the rare situations where political and currency volatility is no impediment to a deal, foreign investors are likely to come up against the problem faced by KKR’s unfortunate deal team – a lack of appropriate targets. While Africa’s corporate culture gradually becomes more sophisticated as the continent integrates further into the global economic mainstream, even the largest companies get by with subpar corporate talent, limited accounting skills and organisational inertia. It’s a state of affairs that favours incumbents but repels new investors.
“In terms of the quantity of assets well administered and well run, there isn’t actually the level of supply you might expect,” says Harrison. “When these assets come to market they tend to attract a lot of interest and auction bidding. Of the work we’ve done this year on the buy-side, most of our clients are not first-time buyers or investors.”
Light at the end of the tunnel?
For all the talk of reduced deal activity, several factors point to a welcome potential recovery in the year ahead. At time of writing, South Africa’s December ANC party congress was likely to decide Jacob Zuma’s successor. Kenya’s conclusive, if controversial, second election returned the business-friendly Uhuru Kenyatta to power in October. In Nigeria, the authorities appear keen to move on from the currency debacle that proved such an unwelcome backdrop to 2017, while Kenyan stability and continued regional integration in East Africa offer further hope for a deal recovery.
“The opportunities are in energy, mining and infrastructure, agriculture is going to be important, as is telecoms. There’s been a lot of disruption – just look at Kenya – but it would appear that things are settling down and investors and developers just want to get on with it,” says van der Merwe.
For those on the lookout for a corporate bargain, opportunity may follow hot on the heels of adversity. While the end of the commodities super-cycle largely brought M&A to a halt in the sector – with reduced mining transactions in South Africa and oil and gas deals in Nigeria – the hunt for consolidation is expected to begin anew as companies readjust to the new environment and the stabilisation of prices.
“We are seeing significant consolidation, particularly in telecoms,” says Citigroup’s Azevedo. “There will also be consolidation in oil and gas. With the oil price having stabilised, confidence is returning and it’s clear who are the winners and losers. This is the time when people will start doing deals.”
As well as the rosier outlook for M&A, the old confidence is also seeping back into private equity houses. The total value of African private equity fundraising rose to $2bn in the first half of 2017, as sector-specific funds reached their close, compared to $1.1bn in the first half of 2016. Long-term demands for health services, power, education and industrial development are all expected to appeal to the appetites of dealmakers.
“The people investing at the moment tend to be on the private equity and family office side, people prepared to take a relative long-term risk which is appropriate to their overall portfolio, and the sectors I’m seeing it in are things like healthcare and education,” says Hogan Lovells’ Skipper. “If you look away from the actual stats of how much M&A there is and look at the underlying trends, there has to be an optimism that things will settle down.”
Yet perhaps one of the most exciting M&A opportunities lies in a country which until recently was off the radar of all but the most ambitious or foolhardy investors – Zimbabwe. Following the surprise military coup that ushered Robert Mugabe from power, the potential economic reform agenda of President Emmerson Mnangagwa could lead to the opening of one of Africa’s most promising untapped markets.
“I think Zimbabwe will improve significantly, how fast we need to be cautious, but the new administration is far more pro-business. They need to deliver on what they said… on that basis I’m very positive and it could be a star in the next two years,” says Azevedo.
If a turnaround can be achieved in a country as discouraging as Zimbabwe, few would bet against smart money flooding back into other markets.
“The idea of Africa as an attractive place to deploy long-term money is alive and kicking and hasn’t gone away. There’s just an element of people sitting on the sidelines while they wait for market uncertainties to iron themselves out,” says Harrison. “There’s always a second layer of the story to tell on the continent and quiet M&A is only one part of the wider economic picture.”